Sunday, September 20, 2020

Headlines Excite, Dictate, or Respond, not Inform - Weekly Blog # 647

 



Mike Lipper’s Monday Morning Musings


Headlines Excite, Dictate, or Respond, not Inform


Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018




As has been previously expressed, investment markets have entered an emotional trading phase. The combination of a US election, COVID-19, a new justice for the Supreme Court, and military accidents, primes the next four months for active trading and makes it inhospitable for long-term investing.


Even when the source is a generally respected, media headlines can be misleading. The wording of headlines is often not the choice or responsibility of the author or the assignment editor, but of a very busy headline editor quick to read, but not as familiar with the topic as others.  Each person that touches an element of the news views it through the lens of their own biases. In the current emotional period it is not unusual to see political bias in each of the news elements, including the headlines. This misdirects the audience and raises questions regarding the utility of the news elements.


In The Wall Street Journal weekend edition there is a headline “Stocks Fall for Third Straight Week”, which  makes it sound like we’ve entered a bear market. (That could please some reporters/editors who have different political views than the higher priced Editorial Board Members representing the official view of the publication.) When one reads the headline, the initial reaction is to expect a meaningful weekly decline, probably double digits. Nowhere in the article is it mentioned that the Dow Jones Industrial Average declined -0.03% for the week, or that the market went up three days during the week. The article neglected to mention something that is probably more bearish, that the Friday decline had a materially larger volume of shares traded. This may be the reason investors need professional analysts to review current market conditions.


One Day Difference, Distinctly Different Conclusions

Regular readers know that my first lens on the market is through the actions of the mutual fund professionals. Historically I have relied on fund performance for the five trading days ended Thursday. I do this for two reasons: 

  1. I used to hire good people from the “back offices” of fund groups and their custodians, where I learned of the natural pressure to quickly finish computations before leaving for the weekend on Friday. Consequently, the Friday calculations were generally not of the same quality as Thursday. 
  2. In addition, when stock specialists set transaction prices there is a natural tendency to reduce capital exposures over the weekend.


For the week ended Thursday, US Diversified Equity Funds (weighted by performance) averaged a gain of +0.98%. However, that is not the full story. Of the eighteen included investment objectives, only one was down for the week, Large-Cap Growth Funds -0.13%. The performance of these Large-Cap Growth portfolios has been dominated by well-known tech companies. To understand the impact of the media’s focus, look at the year to date numbers, where the US Diversified Equity macro group gained +4.71%. Performance was driven by the Large-Cap Growth Fund average return of +20.24%. However, that was not the critical number in understanding the impact of the markets, where the median fund was down -3.18%. (The median is the midpoint of the performance array.) This is significant because if one adds up all the money invested in Large Cap Growth funds plus the money invested in S&P 500 Index funds, it represents only 36.9% of the money invested in the US Diversified Equity group. Thus, it is of interest, but is not a full measure of the performance of the market. The extraordinary gain from the March bottom is not so large that a major overall correction is warranted, a view contrary to one you’d get from reading financial columns this weekend. Another thing not credited is the downward selling pressure exerted on some of the best performing stocks in order to fund the purchase of 17 IPOs which began trading thus week.


A Very Bullish View

A large US brokerage firm believes the initial impact of the Coronavirus began a new market cycle, with profit margins expanding into 2021. They could be correct in the absence of any new negatives appearing, although my own view is that they could be a year early.


Portfolio Management Views

  1. At some point in long-term portfolios there is a danger that every single position does well. This is dangerous because when the inevitable market decline happens, almost all the positions are likely to decline. Some late blooming positions are a sign of a prudent manager who wants to own something going up in almost all market conditions.
  2. By far the largest surprise in many portfolios is my belief that we are not in a permanent low interest rate environment. Since few people are looking for an explosion of interest rates, I am of the belief that good things don’t last forever.


Questions?

What surprises are on your worktable?       




Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/09/mike-lippers-monday-morning-musings-who.html


https://mikelipper.blogspot.com/2020/09/turning-point-or-bump-weekly-blog-645.html


https://mikelipper.blogspot.com/2020/08/caution-ahead-emotional-turns-likely.html




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Sunday, September 13, 2020

WHO YOU SELL TO DETERMINES WHAT YOU BUY AND WHEN? - Weekly Blog # 646

 



Mike Lipper’s Monday Morning Musings


WHO YOU SELL TO DETERMINES WHAT YOU BUY AND WHEN?


Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –




This week showed the value of reverse thinking. Most investors choose what to purchase based on the perceived characteristics of the investment. They choose when to make the purchase based primarily on their own needs or possibly a headline event. This thinking has not produced profits over the latest two weeks.


Who to Sell to?

Basic securities analysis textbooks assume that investors sell to investors that think like them, which is long-term, although the eventual buyer may be another company in a merger or acquisition. One of the nice things about life and markets is that each year brings new people wanting to invest. Each generation produces young people wishing to get rich quickly, who believe that making smart decisions and acting very quickly pulls off that trick. (Wouldn’t we all like to find Eldorado, the mythical gold mine.) 


While sheltering in place the youth discovered their brokerage firms allow them to trade on margin (borrowed money). Stocks and bonds cost too much money and move too slowly, so they quickly discovered put and call options. Options normally expire worthless or are sold, but they can require delivery or acceptance of the underlying shares. To protect the sellers of these options they buy or short the underlying shares. During the last two weeks the market has become aware that in aggregate these options plus some owned by a large Asian fund group is huge. This is one of the explanations of the two-tier market we have been experiencing. 


The first tier is about ten stocks including a couple of Asian companies. Through the end of August these stocks gained much more than +20%. The remaining stocks, the second tier, is still down a few percentage points year-to-date. Our intrepid youth has concentrated their attention on these tech leaders in the first tier. Options are written for various time periods, from a day to multiple years. Most institutions using options typically hold them for one or two months, but these youth are often in and out within two days. A complicating issue is the belief that the equity underlying these trades, on both the buy and sell side, could be as low as 7%. This in and of itself is causing rapid trading on the other side of these transactions. Short-term traders expect the other side of their trades to be similarly motivated by short-term views. During the last two weeks this has been the added increment to the market, adding to both volume and probably much more to volatility.


The Time Hurdles

Politics

As I’ve suggested in prior blogs, we have entered an emotional trading period which can last until mid-November. By the end we will have the initial results of the election. For forward-thinking investors who know history, the impact of the Presidential election will prove to be less important than who will be the chair and probable ranking member of various Congressional committees and possibly sub-committees. It will be this small group that puts words to the President’s wishes. Based on history, campaign slogans will either be totally disregarded or so modified that the results will be very different than what voters perceived on election day. 


By January, I believe both political parties will be splintered into different groups on many basic issues. Committee chairs will not automatically be able to send their wishes to the “floor” of their house without some support from the ranking (senior) opposition member of the committee. While all members always think of their next election, the defeated party will be focused on how to reverse the past election and how to improve their own chances for the next election. The ranking member has less ammunition than the chair, as they aren’t able to appoint sub-committee chairs. Additionally, members from the minority party will undoubtedly be split as to the reason for their side’s loss in the last election and will blame some of the remaining party members. Thus, they will not be easily led. Their immediate concern will be the 2022 mid-term and regaining the majority in 2024, where the two Presidential candidates will likely be new to those roles. 


COVID-19

We are likely to get frequent reports on the progress of vaccine trials and therapeutics, which are not as much in the news but possibly more important in terms of the number of people treated. Personally, I am very concerned with the execution of production and distribution of these lifesaving or at least life altering medicines. These are very large tasks that frequently run into problems. 


Other News Elements Before 2021

  • BREXIT + UK Economic Recovery Faster than Continent
  • Some rising commodity prices affecting some consumer prices


Market Indicators

  • Very few fund investment categories rose this week - precious metals, agricultural commodities, Japanese and European equities
  • NASDAQ fell -11% from its all-time high
  • Dow Theory has a buy signal (often late, but sometimes early)
  • AAII survey sample increasingly bearish
  • Used car prices rising


What Should Investors Do?

Traders should trade, but remember, they want to finish with cash in the end. Investors should sit through this emotional trading period unless the market moves 20% either way. If a specific issue has some unexpected news causing reinterpretation of the situation, perhaps some change might be warranted. In general, sound investors with good portfolios and not too much cash should use a 20% market gain to add to reserves. Investors should use a 20% market drop to look for new bargains, which will benefit quickly if the market adapts to new strategies. (One might consider long-term producers or transporters of natural gas, or companies whose revenues are tied to market prices.) 

  

 

     

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/09/turning-point-or-bump-weekly-blog-645.html


https://mikelipper.blogspot.com/2020/08/caution-ahead-emotional-turns-likely.html


https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.html




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Sunday, September 6, 2020

Turning Point or Bump? - Weekly Blog # 645

 



Mike Lipper’s Monday Morning Musings


Turning Point or Bump?


Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –




Investors can go to school on the lessons learned from September 2-5, 2020. Each day’s lessons can help determine the longer-term implications, suggesting either a turning point, a correction, or a bump. (As usual, my views focus on shepherding the assets of institutions and individual long-term investors.)


Record Index Highs of September 2nd 

All investors are captive to the media and pundits on their platforms. In this “sound-bite” world, the movement of “the market” is described by referencing one or more “popular indices”. If you believe them, the market achieved a high in terms of the recovery, year-to-date, or for all time. The reality is quite different. Using the Standard & Poor’s 500, a high point was reached. However, excluding the five tech-oriented winners and focusing on the investment performance of the other 495 stocks in the index, the average performance for 2020 was -2%.


Reaction to Tech Dominance - September 3rd 

The replacement of three stocks in the Dow Jones Industrial Average and the impact of Apple’s stock split highlighted that the index was becoming more captive to technology. For market historians, the emphasis on tech could follow past patterns of DJIA changes, which tended to occur late in their cycle of market leadership. The probable reaction in a low transaction volume market was to sell with “the market”, which at one point had the DJIA falling more than a thousand points before a wave of buying reduced the losses materially. However, this brought in another wave of selling which caused the DJIA to fall back toward its lows of the day.


The Battle on Friday, September 4th 

This preceded the three-day Labor Day holiday weekend and I suspect margin accounts, particularly those that were heavy users of options, were forced to put up more margin or sell out. Traditionally, margin calls are met by liquidating positions held by the owner or the source of the borrowed funds. I believe that what made this liquidation different was that some of the selling was done by new users of options, some of which were young, inexperienced electronic traders. In addition, there is a printed rumor of an Asian investor holding options on $50 Billion worth of securities. Market makers often take the other side of a derivative trade, which would have added to the volume on a low volume Friday. Few active market participants wished to carry large positions over this weekend.


September 5th - Kentucky Derby Lessons

Long-term readers of these blogs recognize that I’ve learned more about investing at the New York racetracks while at college, than sitting in a New York classroom. With only thirty minutes between races, one learns quickly. Thus, reading about The Kentucky Derby today, I see investment lessons.

  • The single most important factor in making an investment decision is guessing the magnitude of the potential return. The known denominator for the racetrack bettor is the approximate quoted odds for a fist place finish. (The odds for second and third can be calculated by hand, with a little bit of work.) The smallest odds are for the horse that the weight of money believes will win. Favorites only win about 1/3rd of the time and extreme favorites require the bettor to put up more money in addition to the wagered amount. These so-called odds-on favorites only win about ½ of the time. The favorite for this Derby was going off at 3 to 5, which means that a bet of $5 would win $3 in addition to the return of the original wager. To me these are normally bad bets, as “things happen”, or if you prefer “racing luck”. It is like investing in the most valued stock in terms of the highest price/earnings ratio or similar measures. As I expected, the odds-on favorite ran a good come from behind race to finish second, but the slightly less raced winner paid off substantially more.
  • Present conditions are rarely the same as those in the past and they sometimes dictate the result. In this case, as with most Kentucky Derbies, there were probably twice the number of horses racing than usual. Passing tiring horses requires the effort and skill that some horses and jockeys don’t have. Furthermore, for the favorite in the race, it was run with a shorter home stretch than the race immediately preceding it. This favored the horse leading at the beginning, as the race to finish from the last turn makes it harder for the oncoming horses. With publicly traded stocks, the different conditions can be subtle but meaningful accounting differences, as well as the dates of their announcement. As the US stock market is institutionally driven, large market forces are the only buyers able to move highly popular stocks. (Generally, I prefer under owned stocks and funds that own them. Recently, this has been the exact wrong strategy due to the high concentration of ownership in a limited number of companies.)
  • The team behind a horse can be very important. The winning team for this Derby had a trainer who has now won the most Kentucky Derbies of those still training and runs a very people-oriented operation. He and their connections were cheering for the winner in the name of an assistant trainer who had just broken his arm when one of their entries fell on him. Among the owners are a syndicate of 4,600 investors, giving them access to substantial capital if needed. 
  • The trainer instructed the jockey, a previous multiple Derby winner, to use the whip on the left side to keep his young, fractious colt from getting too close to the rail. The rough equivalent I use in picking mutual funds for our clients is applying the decision processes to both a particular fund and its management as a whole. I pay particular attention to the level of specific knowledge portfolio managers and their supporting analysts have on individual issues.
  • Finally, there are horses that do better at particular tracks and distances. Today, many managers are primarily focused on near-term performance years.  Some believe we are in the last phase of an investment cycle and are delaying the sale of principal positions until they reach an expected peak in 2021. There is also one large brokerage firm advisor who thinks that the “new normal” will usher in a new, long cycle. Our job is to select the appropriate length of the current market for each account based on their needs and internal policies.


Question of the week: 

Do you think last week was a turning point or just a bump in the road as we move higher to a new event or stimulus? 



     

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/08/caution-ahead-emotional-turns-likely.html


https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.html


https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html




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Sunday, August 30, 2020

Caution Ahead: Emotional Turns Likely - Elections and Coronavirus - Weekly Blog # 644

 


Mike Lipper’s Monday Morning Musings


Caution Ahead:

Emotional Turns Likely-Elections and Coronavirus


Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –



When the battlefield is quiet, expect to be attacked, is a lesson from the US Marine Corps. For bullish equity investors the low volume of August trading should signal a need to expect change. The most dangerous short-term change is one spurred on by emotions, rapidly bringing into action holders of excess cash or large equity holdings.

The calendar provides two events that could quickly galvanize emotional responses, the forthcoming US election and reports of successful vaccines/therapeutic COVID-19 treatments. Both could mobilize a large amount of almost instant trading from thrilled and disappointed investors. Based on a lifelong study of turning points, I suggest caution on the part of investors who believe in rusty or non-existent trading skills. Furthermore, very soon after the announcement a counter trend could appear, reducing the size of the initial pop and in some cases completely reversing it. As more information becomes available, the implications of the announced event will often become clearer. Even if further information reinforces the initial announcement, the length of time varies before complete utilization becomes evident. Thus, investors will have time to calmly adjust their holdings. 

Profitable courses of action build on some factors present before the headline event, while others will have little to no future impact. Some will advise you of the critical present factors supporting the future event, I am not so privileged. All I can do is briefly list some of the factors that might support the trends post the announcement, including the subsequent reversal moves:

  • The biggest investment news of the week was the changing of the components of the Dow Jones Industrial Average (DJIA) and the reweighting of Apple*. The current producer of this most senior of US stock indices is S&P Indices, owned by Standard & Poor’s, who consults with some of the editors of The Wall Street Journal when making changes. On Monday they will delete Exxon Mobil, Pfizer, and Raytheon Technology, adding Sales Force, AMGEN, and Honeywell. In addition, on the same day the weight of Apple in the index will be reduced due to Apple’s four for one stock split. It will be replaced as the company with the heaviest weight in the index by United Health.

Because of the dominance of Dow Jones through its wires and publications, most investors tend to believe that the DJIA measures the US stock market. That a thirty-stock market price weighted index is “the market” with its’ 30 stocks and not the S&P 500, the Russell 3000 or the Wilshire, with its original 5000 stocks, shows the power of the media. Clearly, global indices have even more components. Nevertheless, the DJIA has done a reasonable job of tracking high-priced US stocks. Part of its success is due to dropping components when their outlook appears to be slowing. (Some components comeback into the index after a large merger.)

While most market followers will continue to use the DJIA as a market measure, I will not for the next twelve months. While statisticians will link the new components and the reduced weight of Apple, I believe they have created a new measure. After one year I will see the level of correlation with the S&P 500 and if the gap is close, I will return to using it as a measure. Once again, the editors may have done a good job of changing the components to represent our economy. Over the more than one hundred years of its existence, they have done a good job of switching the emphasis from consumer products, to industrials, to tech and then to high-tech.

(*) Owned in personal accounts

  • Record high prices achieved this week for both the S&P 500 and the NASDAQ Composite confirms the view that the American Association of Individual Investors (AAII) sample survey of market direction for the next six months is a contrarian  indicator. For the first time in many weeks the leading bearish prediction fell below an extreme reading of 40%. 
  • 79% of the WSJ’s weekly prices rose. This may reflect some shortages, but it also reflects merchants trying to increase prices to make up for forgone profits. Despite many learned economists being quite sanguine on inflation, I expect the Fed to get and exceed its desired 2% inflation target.
  • Unfortunately, I expect layoffs will rise for a while. The Russell 2000’s second quarter estimated revenues dropped -19%, with earnings dropping -99.1 %. This indicates to me that smaller companies have kept their staffs to preserve their hard to get employees. So far, third quarter revenues have not risen much. There is a good chance that instead of preserving the work force the focus will shift to preserving the firm. I suspect private firm closings indicate a similar trend.
  • The bond market is moving contrary to the stock market. Of thirty-one fixed income mutual funds investment objectives, only twelve gained for the week and they were equity tinged high-yield or pro inflation vehicles. The maturity yield curve tightened, with maturities of more than two years rising.
  • There may be more longevity to the current market than appears. Typically, markets don’t peak until they exhaust all available cash and there is a lot of cash on the sidelines today. In addition, there is a lot of capacity to increase margin borrowing.  Remember, margin can be used to support short sales, as well as the more popular long purchases.

Working Conclusions:

  • Trading oriented accounts should be prepared to make lots of small moves and be willing to reverse direction when appropriate.
  • Capital appreciation accounts should look for bargains by being contrary.
  • Capital preservation accounts need to recast their portfolio in one or more other currencies to determine their risk of only evaluating their accounts in dollars. European investments may look attractive for “value” oriented accounts and Asian investments could be attractive for long-term growth investors. Multi-generational investors should develop an understanding of the long-term outlook for selected investments in Africa and the Middle East.



Share your reactions and thoughts with us. 



     

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.html


https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html


https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html




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Sunday, August 23, 2020

The Week’s Fashions and Our Most Dangerous Asset - Weekly Blog # 643

 



Mike Lipper’s Monday Morning Musings


The Week’s Fashions and Our Most Dangerous Asset


Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –




There are instances where very current observations can have long-term implications. The week that ended last Thursday night was quite possibly such an instance. Each week I examine a report on the performance of over one hundred different investment objective peer groups. Since the competitive game, not the investment game, is beating “the market”, I look at what types of funds that have beaten the S&P 500 Index Funds average performance. In the quiet lazy summer week, the index gained +0.40%. The following is a list of the seventeen peer groups that beat the index:

Base Metals Commodities   +2.83%

Precious Metals           +2.43%          

Energy Fund Commodities   +2.11%         

Large-Cap Growth          +1.83%         

Science & Technology      +1.60%         

Global Science & Tech     +1.58%          

Multi-Cap Growth          +1.52%         

Convertible Securities    +1.37%        

Consumer Services         +1.25% 

General Commodities       +1.13%

Agricultural Commodities  +0.78%

China Region              +0.77%

Global Large-Cap Growth   +0.77%

Global Multi-Cap Growth   +0.70%

India Region              +0.61%

Alt. Active Extension     +0.49%

Telecommunications        +0.45%

Most of these leading groups have been leading for some time, benefitting from momentum. The commodity owning funds look forward to higher prices for them and inflation for their customers resulting from shortages of supply.

One could say that these groups were deemed attractive by some pundits and their followers. Thus, if one would invest in most of these, the bet is not on the fundamentals of the underlying companies and commodities, but on the expected pronouncements of various pundits. To me, this suggests that these funds are likely to be more volatile than most funds. Thus, they make sense for those who believe in their trading skills or have a firmly held view of the investment cycles of the future.


CASH Is the Most Dangerous Asset in the Portfolio

Cash is a dangerous asset, not because it may lose some value, but because of how we exit from it. Remember, almost without exception every single loser we have had started from exiting cash. Potentially, the biggest problem in having cash is the way we think about it, our portfolio, and ourselves.

Whether we have a thousand, ten thousand, one hundred thousand, a million, ten million, one hundred million, one billion, or ten billion, as we jump each successive hurdle it gives to us a different attitude about ourselves, our status among others, and the safety of our situation. However, these emotional and intellectual highs can be very misleading. 

Cash is a receipt from past activities and its value changes imperceptivity every day due to the interaction of currency and inflation. Additionally, changes in tax regulation and investment/legal practices change the purchasing power of cash. Another critical element impacting how we feel about cash and other attributes of wealth is the perceived wealth of others, either foolishly published or gossiped. (The wealthy lists are not adjusted for present debts or future commitments. Some multi-millionaires have assets tied up and have little or no “walking around money”.)

The expected use of cash defines the flexibility of wealth. Large families in terms of number or generation of people need to think about the state of their physical, emotional, and mental health when considering future spending. Only some family members and their highly trusted advisors have a real understanding of the extent of cash and other indications of wealth. Often, no one has a complete picture of the emotions attached to assets/liabilities and how that influences their disposition.


Working Toward Solution Suggestions

The best suggestion I have is to adopt a holding company philosophy like Berkshire Hathaway, which is a holding of some clients and held in personal accounts. With over 60 operating entities and over 100 separate financial centers, their current operations retain enough of their cashflows to meet current needs and send the excess to headquarters for future investments.

The first suggestion deals with the proper identification of reserves to meet specific needs. It can include specific elements such as buying future residential property, education expenses, specific medical needs, and a loss of employment reserves. Determining the size of the specific reserve will at best be guesswork, but some numbers are better than none. A much more difficult task is guessing the range of future dates when the reserves will be tapped. It is at this point that an intelligent allocation of cash and risk/return assets should be made. The closer the likely expenditures, the higher the allocation of cash or extremely high-quality short-term paper. However, there are risks associated with funding long term needs with short-term paper and cash. My own view would be the following reverse ladder:

  • 100% cash for assets to be spent in the next 90 days
  • 80% cash for assets to be spent one year in the future
  • 60% cash for assets to be spent two years in the future 
  • 50% and no higher in cash beyond that 

My second suggestion is to divide one’s portfolio into two separate parts, the reserve element just mentioned and an investment portfolio with at least a ten-year view, potentially extending beyond multiple generations.

The investment portfolio should avoid holding cash except for a tactical reserve, with a time lock forcing some commitment if the tactical reserve remains after 18 months. Remember the following things:

  • In an investment portfolio cash is a decaying asset due to inflation and currency. 
  • If you must reduce or eliminate cash, the investment opportunities are vast and include some relatively safe alternatives. 
  • Long-term successful investors often go through periods where they are very lonely.     

 

Questions of the week: 

  1. Do you monitor the opportunities to invest investment cash?
  2. Do you review your reserves periodically to ensure that they are appropriate? 
  3. What was the last time you adjusted your cash levels and what was the result? 

    

   

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html

https://mikelipper.blogspot.com/2020/08/more-to-learn-by-seeing-more-weekly.html



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A. Michael Lipper, CFA

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Sunday, August 16, 2020

Changing Investment Directions-Different Views - Weekly Blog # 642

 



Mike Lipper’s Monday Morning Musings


Changing Investment Directions-Different Views


Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –



August Calls

Market analysts have frequently identified August as a month of change in market direction. During a period of normally low volume, a little extra volume in the face of vacations can have a disproportionate impact. In addition, August usually firms up detailed plans for the highest grossing 4th quarter, while preliminary plans for the next calendar year are being finalized prior to final approval. (But we are not living under normal conditions. Thus, I believe it would be wise to adopt a “fan approach” to planning, with at least a high, low and middle ground, to prepare for the probability that there will be rapid changes that require action.)


Because of my professional life experience I start each analysis looking through the mutual fund industry data, which is often a useful clue to both markets and the broader economy. For the week that ended last Thursday night, “Value Funds” gained +2.25% on a weighted average basis. This compares with a tiny loss of -0.02% for the similarly weighted average for “Growth Funds”. Most often the investment trends that occur within the US market also occur in the international markets and this week it was true for both the international funds registered with the SEC and the “offshore” funds we track. Nine value funds were in the 25-best performing mutual funds for the week. Also on that list were five financial sector funds. Overall, financial sector funds gained +3.08%, with industrial sector funds doing slightly better +3.10%. The prior leading sector groupings declined, Science & Technology -1.56% and Global Science & Tech -1.45%. 


While a few weeks of performance does not guaranty a longer-term trend, all longer trends start with a few observations. The stock price moves of value vs. growth are way ahead of changes in the direction of earnings, although they are in parallel with many views expressed by politicians around the world.


China Pulling Ahead

Despite the rising level of tensions between the US and China, it appears on the surface that the trends within China are improving. One of the ways I follow what is happening in China is by reading the research provided by the fund management group, Matthews Asia. The following brief points were derived from their research.

  • There were no COVID deaths in China in the first 12 days of August.
  • Auto sales are improving on a broad scale in China, particularly for foreign brands. In July, Toyota increased +19.1 % (including Lexus +38.6%), Honda +19.1%, Nissan +11.6%. General Motors sold more cars in China than in the US.
  • Last year, 60% of China’s GDP growth came from internal consumption, with only 17% of GDP being gross exports and only 17% of that going to the US. While the US and most of the rest of the world have problems with the policies and activities of the Chinese, we cannot realistically isolate them. We need to come to some accommodation with them for us all to grow.

The “Sage of Omaha” Throws Curves

Warren Buffett for many years threw out the first pitch for the local baseball team. In the second quarter of 2020 he threw a curve ball to investors with his second quarter transactions. Even if our clients or personal accounts did not own shares in Berkshire Hathaway, we would still study the company’s financials and/or pronouncements. I have suggested that a well-constructed financial and business graduate course could be conducted using only their documents. Their successes are legendary, but their few errors are even more valuable as teaching moments. Last week they published their 10-Q report and their second quarter publicly traded securities portfolio with the SEC. Each is worthy of detailed study.


The 10-Q reveals that the company should not be compared to either an open-end or closed-end fund, as it is intelligently leveraged with borrowed money in the form of debt and potential future payments, using customer float and future tax payments. Offsetting the leverage are large amounts of short-term US Treasury bills and other high-quality fixed income/cash holdings. The company is an investment portfolio of publicly traded and private equity holdings that utilize excess earnings for operational needs to buy new investments. It does not currently pay cash dividends, as shareholders benefit from the increase in value of their holdings. Recently, they have become a relatively small buyer of their own stock. Unlike many corporate CEOs and Portfolio Managers, Warren Buffett and Charlie Munger’s time horizon is that of their shareholders’ heirs. Thus, any large- scale disposal of assets comes as a surprise.


The publication of their report to the SEC of their publicly traded securities transactions in the second quarter was a surprise. In summary, they materially reduced their holdings in most bank stocks, although the report did not provide an explanation as to why. Earlier in the year they did provide an explanation as to why they sold out of all their airline stocks. They felt that it would be a period of years, not months, before air travel returned to 2019 levels. Without an explanation from “The Sage”, I am searching for one and have come up with two possibilities:

  • The results for the first quarter were depressing and that got to him. (I use the singular, as the size and long-term holding period suggests that this was the curve ball pitcher himself making the primary decision.) Many felt that way, including a very long trail of the AAII weekly sample survey.
  • While the political inclination of Mr. Buffett tends to lean toward the Democrats, he may have been worried about Berkshire’s huge position in the financial services sector. The thought that a specific senator from Massachusetts might be Treasury Secretary could well be scary. 

I have great respect for Warren Buffett and even more for Charlie Munger and have learned a lot from them. They have also enriched our clients and personal accounts. The only thing I promise to our accounts is that I will be wrong from time to time. Hopefully, I won’t take too long to recognize my mistake and correct it.  Nevertheless, I am not reducing our exposure to the financial sector at the moment, as with rare exception their stock prices do not reflect their earnings power in normal times. (A lesson I learned from the great John Neff.) I will admit that branches will have to be converted or closed. Quite possibly, lenders will be required to have equity in their borrowers, or similar socially driven radical changes. Governments and societies are unlikely to function successfully without a viable financial sector.


Question of the Week: What are your thoughts?

    


   

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html


https://mikelipper.blogspot.com/2020/08/more-to-learn-by-seeing-more-weekly.html


https://mikelipper.blogspot.com/2020/07/mike-lippers-monday-morning-musings.html




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Sunday, August 9, 2020

Rotating Leadership Likely on the Horizon - Weekly Blog # 641



Mike Lipper’s Monday Morning Musings


Rotating Leadership Likely on the Horizon


Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –




Voters and investors have difficulty separating reporters, analysts, and forecasters, as they themselves don’t understand their function. Unfortunately, each is required to briefly summarize their work without confusing their audience, any more than they are already.  The standard way of reducing the clutter is to find the lowest common denominator or distinctive identity and equate that with all the factors that appear to fit. Thus, one can build a house with a hammer, screwdriver, and a saw.


This approach worked reasonably well for many years but is showing signs of not working as well, due to the size of the lowest common denominator shrinking in both the political and investment spheres, as reporters capture gross movements of a limited number of identities. Analysts track the movements of these identities and most forecasters extrapolate present trends into the future. As a defender and generator of investment capital, I think our responsibility is to look for future changes that in total are threats or opportunities. Some examples?


Politics is a witches’ brew of both policies and pragmatism. On the runup to a much-debated election, most of the chatter is essentially about policies, with very little execution through various governmental actions. Beneath the surface, each of the two major political parties are increasingly split on the implementation of policies. There has been almost no discussion on moving all legislation through the houses of Congress, state legislatures, city councils and even the White House. At this point in the calendar, I suggest very little will pass until later next year. We will then need to deal with the relatively small amount of time before the demands of the 2022 Congressional election materialize, which is likely to dictate the success of the person in the White House. Thus, I have little confidence in all the political inputs into investment decisions, at least for quite a while.


Changing Investment Leadership through Mutual Fund Lenses

Professionals often use more and different tools than the public or the media. In looking at mutual fund performance, most look at the average performance for a category of funds. However, there are two other measures that are useful to me, weighted average and median results. The first measures how the dollars invested are doing and the second measures the midpoint of the group. For the year to date period, there were 2483 large capitalization funds with total assets of $3.2 Trillion. They were essentially flat at +0.40% through August 6th. However, on a weighted average basis, the same group of funds produced a return of +9.98%, a +9.58% spread vs. the average. One of the reasons I expect a rotation away from the extreme focus on growth, is the ten-year spread of large-cap vs. the average only +4.05%.  Growth funds as a category, including large, mid, and small, both domestic and international, had a median ten-year average gain of +11.12% vs +10.35% for the current year to date period.


The real concern with growth is that there are only two handfuls of big winners and perhaps forty performance followers. The spread by size is unsustainable. Year to date, Large Gap Growth is up +21.19%, with the lead taken over by the Mid-Cap Growth +21.53%. The international Small/Mid-Cap Growth peer group was the only negative performer for the period -0.23%. At some point I expect “value” funds to get some exposure as leaders. In terms of the three different performance measures, the group is down -12% year to date. The ten year average compound growth rate was +12.57%, the weighted average +10.96% and the median +11.12%.


Can One Be Early with Value?

The great John Neff of the Windsor Fund, but he was an original thinker, both as an analyst and then portfolio manager. He trained at a mid-western bank before joining Wellington Management in Philadelphia, where he stayed after Jack Bogel pulled the Wellington Funds out of Wellington. After he was fired by the firm, he was resurrected by the outside fund directors to form Vanguard. The portfolio of Windsor was largely comprised of companies headquartered within 500 miles of his Valley Forge office and was heavy weighted toward financials and industrials. When I visited with him during a recession, many of his stocks had little or no earnings, particularly Citi Group. He explained that his stocks were cheap on an earnings power basis and that was more important than current reported earnings. During the recovery he proved to be correct. 


When John retired there were a few retirement dinners for him. At a small gathering in New York, open primarily to those connected with Wellington and Vanguard, there were only two outsiders invited, John Reed, the CEO of Citi, and myself. While many investors define value in terms of liquidating value, John defined it in terms of future value based on the in-depth analysis of earnings power. We continue to search for the new John Neff, as their time is probably coming.


The “Market” is Searching

Each week in Barron’s there is a list of the twenty-five best and ten worst performing funds for the week from my old firm. Normally, over half of each list is from a single peer group, but this week the lists were much more diversified. There were fourteen separate peer groups identified for the winners and eight for the laggards. This indicates that market participants are searching for new winners and losers to be sold. This is a sign that we are probably in a new phase.


Question of the Week: 

Have you found some new names of interest? Or have you given up on any disappointments?

  


   

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/08/more-to-learn-by-seeing-more-weekly.html


https://mikelipper.blogspot.com/2020/07/mike-lippers-monday-morning-musings.html


https://mikelipper.blogspot.com/2020/07/that-was-week-that-was-change-weekly.html




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To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com


Copyright © 2008 - 2018


A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.